Audits do not Provide Stupidity Protection - TurnAround Executive Coaching

Is it possible that your company needs stupidity protection more than a good audit? Audits (and the CPA function in general) are very good tools to prevent fraud and present a conservative picture of the organization. However, Management Accounting takes things one step further to protect against stupidity. Every company needs both protections.

My company has strong internal controls. It’s a challenge because we are spread out over several locations for both program and tuition collection. 12 managers charge expenses to the income statements for their departments. Over time, we have developed a careful manual of Financial Procedures, update it annually, use GAAP presentation, and work with the auditor to test for fraud.

It was a shock to see that none of this due diligence mattered when we made an investment greater than our resources. It has been two years to recover from that decision and the rescue is arriving from Management Accounting.

What is the difference between Management Accounting and Financial Accounting?

Financial accounting is standardized so that it is easier to compare several companies. Management Accounting slowly adds accounts to the Chart of Accounts and changes reports as your company changes. The results of Management Accounting give advice that is unique for your business at this moment. Because of that, we say that Management Accounting is future oriented, private advice for good decisions while Financial Accounting is historical, public fair presentation of the company. Both types of Accounting are required but Financial Accounting gets 90% of people’s attention.

Nonprofits need Management Accounting even more than For-Profits. For-profits have more access to cash and financing in the event of a stupid decision. They are more likely to own property that can be security for a bank loan. They may be able to issue stock or offer a bond issue. Nonprofits do not have these tools and it makes the need for financial advice about future decisions more acute.

What are examples of Management Accounting that nonprofits typically ignore? I’ll mention two of them.

Imputed costs – Assume that you receive a contract for student services for 100 students at $1,000 per student. Upon opening registration, you discover that 150 students want the service and you do not have additional funding. In financial accounting, you would debit income of $100,000, and debit expense for $80,000 for program and $20,000 for administration. Deliver an excellent program and you feel very successful under Financial Accounting.

Under Management Accounting, you have left the need for services and money of 50 students on the table.  The imputed cost this decision is the administrative portion of $10,000 (50 students * .20 * 50,000). With this change, the Income Statement for the program reports a $10,000 deficit under Management Accounting instead of being balanced under Financial Accounting.

Management has a decision to make after reading the Management Accounting report –

  • ask for more contract funding,
  • ask for fee for service for additional students,
  • ask for charitable donations, or
  • leave matters as they are.

Very few of us would have given this situation a 2nd glance under Financial Accounting.


Cash Flow Statement – In Financial Accounting, the Cash Flow Statement is still new and underused. One underused feature is to separate New Investment Projects from Continuing Operations Projects in the Chart of Accounts and New Fixed Assets for New Projects from New Fixed Assets for Continuing Program. Financial Accounting has no such interest in this separation.

Assume that 100 students are in your continuing program and you buy chairs, computers, and other fixed assets (charged to New Fixed Assets for Continuing Program) as they are destroyed each year. Over a period of 6 years you notice that you spend $50 per year per student.  Management Accounting then advises that you add $5,000 to the next capital budget for continuing operations Fixed Assets. That information could not be determined easily without creating separate Fixed Asset Accounts for Continuing Program. You now have advice on what level of Fixed Asset investment is required each year to maintain program at the quality and size you are operating.

You may feel overwhelmed by the number of ways that Management Accounting can probe and rearrange your data. It’s also true that some reports from Management Accounting provide no new insight. The point is that every agency should be doing some Management Accounting to spotlight decisions that will make a difference.

Most of us depend on Sheer Dumb Luck as we go from year to year with our companies. The audit is a reasonable attempt at fair reporting. Management Accounting is one more tool to bring some science and insight to decisions. My advice is to lead with assistance from both approaches.

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